Thaler on Nudging People to Make Better Choices

University of Chicago Graduate School of Business economist Richard Thaler has spent his career arguing that people are less-than-rational when they make economic decisions. As a leading figure in behaviorist economics, he’s long argued that policymakers need to guide people where they’re prone to fail.

Thaler

In his new book, “Nudge,” written with University of Chicago Law School professor Cass Sunstein, he looks at how policymakers might go about doing that. He and Mr. Sunstein make an argument for policies that guide people toward making optimal decisions while not depriving them of their ability to make a choice. They call this idea “libertarian paternalism.” (“Why not paternal libertarianism?” asked Nobel laureate Daniel Kahneman at a recent event. “It’s no worse,” Mr. Thaler replied.)

Mr. Thaler discussed his work with the Journal’s Justin Lahart.

WSJ: I just ate a salad at my desk that’s advertised on its label as 98% fat free. How much better is that for me than a salad that’s 2% fat.

Thaler: A great question. While we can be reasonably sure that 98% fat free is no better for you than 2% fat, we can also be pretty sure that the salad seller chose the label it did with care. We know that the way a product is described, or as the psychologists say, “framed,” can have a strong influence on choice. In the language of our book, you have been “nudged” to buy that salad. Of course, that might not be all bad, if the alternative was a meat-lover’s pizza.

WSJ: We’re all familiar with how marketers, advertisers and, especially these days, vote-hungry politicians use framing to influence our choices. In your book, you argue that policymakers might use framing and other behavioral methods to get us to make better choices. Automatically signing employees up for their 401(k), with the option of dropping it, might serve them better than having 401(k) participation depend on their signing up. But at the same time, isn’t using “nudges” to modify people’s behavior manipulative?

Thaler: Nudges do alter behavior but calling them manipulative is unfairly pejorative (perhaps even manipulative!). As we stress in the book it is impossible to avoid some nudging. Much as we might wish for it these days, we cannot expect politicians to stop speaking. So they choose their words carefully. One is either pro choice or pro life. No one is anti-choice or life! Once we accept the fact that some nudging is inevitable, we can move on to the question of how nudges can be used to improve people’s lives, as judged by themselves.

WSJ: If you could put just one nudge into place in the U.S., what would it be?

Thaler: Picking your favorite nudge is a bit like picking your favorite child, however, if I have to pick just one I would go with our idea for electronic disclosure, what we call RECAP. The basic idea is that many aspects of our lives have gotten so complicated that it is no longer feasible for sellers to comply with “plain English disclosure.” This is certainly the case for mortgages, which have become very complex, but it is even true for cell phone plans and credit cards. Traditionally regulators have put into place rules to prevent “sharp” practices, but these rules are often a bad idea for two reasons. First, they can prevent innovation. Second, as soon as you abolish one shady strategy, sellers think of a new one. So, instead of bans and mandates, we propose that sellers be required to simply disclose what they are doing electronically.

Here is how it would work for credit cards. Once a year your credit card provider would have to send you two electronic files. The first would be essentially a spread sheet that characterized every way in which the provider can charge you for something, from late payments, to interest rate changes, to charges for currency exchanges. The second file would just be a list of everything you did in the past year that incurred a charge. We predict that Web sites would quickly emerge to translate and evaluate these files so consumers would understand how they were being charged and what they did to incur charges. The web sites would also provide information on alternative suppliers that would be better given the customer’s usage.

We think this idea would work very well in many domains, from mortgages, to cellphone plans, to the Medicare prescription drug program.

WSJ: In our personal lives, what ways can we employ nudges to help us make better decisions? Are there any that have worked especially well for you?

Thaler: We both try to make as much use as possible of automatic payment mechanisms. Being absent-minded professors who travel a lot, it can be difficult to get the bills paid on time. Automatic payment is wonderful. However, many credit cards try to make it difficult to set things up to pay your credit card bill in full each month. Generally the default is to pay the minimum. This is an example of a self-serving nudge by business. We encourage consumers to give their business to credit-card issuers who make it easy to pay your bill in full each month.

WSJ: You and Cass Sunstein have both advised Barack Obama, and your friend and colleague Austan Goolsbee is Sen. Obama’s chief economic advisor. Do you see ways in which the Obama platform employs nudges?

Thaler: There are several ways in which the Obama campaign employs nudges. For example, the idea of automatic enrollment is used in several domains such as his health-care plan, and of course, his reluctance to have a mandate is in line with our philosophical approach. More generally, Obama has embraced the idea of improving the interface between citizens and the government by employing better choice architecture. Obama refers to these ideas as creating an “Ipod government,” meaning that interacting with the government would be as easy to use as the Ipod. One example is Goolsbee’s idea to offer people with no outside income or itemized deductions a prepared tax return they can simply sign and return. This would save tax payers lots of time and money.

Also, the campaign has adopted some of our ideas on improving the Medicare Prescription Drug program. The designers of that program missed the essential point that simply offering people lots of choices (there are 50 more plans per state to choose from) does not make people better off if they are unable to do a good job of picking among the plans. It would be easy to offer participants suggestions that would save both the beneficiaries and the government lots of money. Finally, the campaign has adopted some of our ideas on making the terms of credit card and mortgages easier to understand and more transparent.

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